Nov 11, 2024
Coal is the most carbon-intensive fossil fuel, so phasing out coal power is a top priority for mitigating climate change. Yet, despite progress in several countries, global coal demand reached a record high in 2022. Quitting coal has proven difficult, especially for developing countries.
It’s not for lack of alternatives: In much of the world, solar and wind power are now the cheapest options for new electricity generation.
The problem is that, unlike their clean replacements, coal power plants already exist. They cost tens of millions of dollars to build, and with reasonable maintenance, they could operate for 40 or even 50 years. The owners may still be paying off the loans they took out to finance them.
So from a pure financial perspective, doing right by the climate can make no sense.
“Think of all the revenues that need to be forgone,” said Joan Miquel Carrillo, blended finance lead investment officer at IDB Invest, the private sector arm of the Inter-American Development Bank (IDB) Group. This is why, except when driven by government policies, most early retirements to date have involved older plants that, for one reason or another, had become unprofitable or undesirable to run.
But what if the economics changed? An IDB Invest project in Chile supported by the Clean Technology Fund (CTF) shows how that could happen.
Adapting to new realities
In 2018, Chile published an energy roadmap that committed to setting a firm timeline for retiring or converting coal power plants. The following year, ENGIE Energía Chile – part of a French-based energy conglomerate – closed two coal units in the Tocopilla Thermal Complex, in the country’s arid north, and signed an agreement with the government to close its last two coal units there by May 2024.
ENGIE has been exiting the coal business as part of its pledge to reach net zero emissions by 2045. It has sold some plants and is gradually closing or converting the rest. To replace its coal-fired generation in Chile, ENGIE has turned to solar and wind power, backed by batteries. That’s where IDB Invest comes in.
IDB Invest put together a US$125 million financing package for ENGIE’s 151 MW Calama Wind Farm, including $74 million of its own funds, $36 million from the China Fund, and $15 million blended finance loan from the CTF to support a groundbreaking approach to monetizing the benefits of early retirement of coal plants.
ENGIE agreed to close the Tocopilla units shortly after the wind farm began operations. The project team designed a methodology, publicly available in English and Spanish, to quantify the emissions avoided by the early closure. At the end of the 12-year loan term, interest payments will be reduced based on the amount CO2 emissions avoided. If a regulated carbon market were to emerge during the life of the loan, then ENGIE could sell its credits on carbon markets instead, and the CTF would get a share of the profits, if any.
“The idea is that if a coal power plant is a profitable business, we need to provide a tool to account for the loss of revenue and a way to generate additional income for those who voluntarily opt out,” Carrillo said. “And that requires the emergence of a new asset class: a coal transition credit.”
Scaling up a successful model
Such credits do not yet exist as an asset class, but the CTF-financed project is showing how they can work. If they can be successfully established and traded on international markets, Carrillo said, concessional finance will no longer be needed. However, blended finance and carbon markets intersect during the emergence of the asset class by providing a floor price that can affirm business decisions as early as possible and create confidence in the coal transition credits.
A major challenge with carbon markets has been ensuring the integrity of credits – that they truly represent additional, permanent emission reductions. From that perspective, Carrillo said, a coal phase-out credit “might be one of the most valuable carbon credit types on the market, because additionality, performance and permanence are easier to discern and monitor.”
ENGIE closed the Tocopilla plants in mid-2022, and Chile’s energy mix is changing quickly. In 2018, coal accounted for 36 percent of power generation; in 2022, the share was down to 22 percent, while solar and wind power provided more than 26 percent of Chile’s electricity.
IDB Invest has been looking for opportunities to apply its new approach more widely, including in the Dominican Republic under the CTF’s Accelerating Coal Transition Program. Several studies have also highlighted the deal as an example of the role of results-based finance and innovative development finance in accelerating the coal phase-out around the world.
“This one was a pilot, but it’s meant to demonstrate the model,” said Carrillo. Future projects can take the same approach – and through the consolidation of the asset class it can achieve the scale required globally.
According to the IMF Study “The Great Carbon Arbitrage” in terms of social returns there is no better deal for humanity than phasing down coal and replacing it with renewable energy. Pilots like IDB Invest’s projects in Chile using CTF resources, can pave a way for coal transition credits as one of the most efficient tools to bring the necessary scale to accelerate those social returns through an orderly and just transition away from coal.
